Yesterday, Paul Krugman wrote an interesting OP-ED piece in the NY Times (here) arguing essentially that the EU economy has been "...wrecked in the name of responsibility." Evidently, the EU economy is not recovering as fast as the US economy and economists are starting to ask why. For many years now, Paul Krugman has been arguing that Austerity policies designed to balance budgets during an economic downturn (such as the 2007-2008 Financial Crisis) are wrong-headed and irresponsible (the same argument John Maynard Keynes made during the Great Depression of the 1930s). The US followed the Keynesian prescriptions with the 2009 American Recovery and Investment Act and the EU followed the path of Austerity. The poor performance of the EU economy seems to vindicate Krugman's position.
The idea of imposing Austerity policies during an economic crisis has never made any sense to me especially when governments have long lists of underfunded infrastructure projects, people are out of work and interest rates are almost zero (a great time to invest). Krugman notes that the US economy does have a better set of automatic stabilizers (Social Security, Medicare and Food Stamps) than does the EU. Finally, the EU currency union without a political union has also never made sense to me and has seemed to tie the hands of particularly the peripheral countries in the EU.
At the same time, using economic policy to return the economy to its potential level of output also does not make sense to me. Does anyone really expect to return to a level of output that existed at the peak of an economic bubble? The graphic above plots real GDP for the EU countries (the black line). The dotted red line is the BAU (Business-As-Usual) attractor path for EU GDP. A comparison of the attractor path with actual GDP shows that the EU had been in a growth bubble since before 2000, well before the 2007-2008 Financial Crisis. In the late 1990's or in 2007, did economists really think that the bubble growth path (solid red lines with arrows at the end) could be continued into the future? I'm going to guess that some economists and financial analysts did expect the EU economy to continue on the red take off into sustained growth paths. The BAU attractor model, on the other hand, shows that the EU economy is right about where it should be after the bubble. To say the economic policy failed to return the EU economy to prosperity is wrong.
What economic analysis is missing right now is models that would generate attractor paths. To say that the EU is performing poorly is to beg the question "Compared to what?". It's just not enough to argue casually that the EU should be growing as quickly as the US. The EU and the US are separate economies with different internal dynamics and different attractor paths.
